INVESTMENT AND RISK MANAGEMENT
ASSIGNMENT 1
GROUP 4
Objective:
To construct an optimal complete portfolio for a client whose maximum acceptable level of risk is a standard deviation of 20%.
Selection of publicly listed stocks:
Table 1
Company
Ticker
Stock type
Industry
Stock Style
American Airlines
AALi
Cyclical
Airlines
Large growth
Tesla Motors
TSLAii
Cyclical
Auto manufactures
Large growth
Citigroup
Ciii
Cyclical
Financial services
Large value
Merck & Co Inc
MRKiv
Non-cyclical
Healthcare
Large value
In order to achieve efficient diversification in the portfolio, we took four different stocks from four different industries. The selection criterion was based upon one simple assumption that was to reduce the correlation between the stocks. This was done to reduce the overall risk of the Risky Portfolio with a return that is greater than the market (S&P500).
Therefore we took three cyclical stocks and one non-cyclical stock to balance out the overall volatility (risk). We took Merck and Tesla stocks to ensure that the portfolio has lower correlation.
Determining the opportunity set:
Monthly historical stock prices for the past five years of each stock were used to calculate their expected return and risk. The risk free rate of 3.28% (0.27% monthly) was calculated by taking an average of the yearly market yield for the past 5 years on US Treasury Securities with a maturity of 20 years.
The first step was to create a covariance and correlation matrix, which was either done through formula (ƒ = COVAR.S/CORREL) or matrix multiplication. After that we took random weights (ƒ = RAND) of the four stocks (constraintto construct different possible portfolios which were either lying on the efficient portfolio or even behind it.
Computing the Efficient Frontier of Risky Assets
The efficient frontier of risky assets can be constructed from any two...